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June 12, 2013

Finke Says Jump in Rates No Panacea for Savers, Retirees: Live Blog, Day 1

Sitting in a lonely press room Wednesday afternoon at the Morningstar Investment Conference (I’m the second reporter to arrive—the first, impressively, came here all the way from Taiwan) soon before the annual gathering kicks off, a table full of investment literature catches this reporter’s eye.

A dizzying array of fund data, newsletters on a wide range of investment topics and research reports are on display. With pride in my news instincts, I look for the research report with the latest date, and am disappointed, initially, that it is no more recent than January—half a year ago.

My journalistic emotions recover when I note the seeming contradiction between the premise of the paper—that systematic withdrawal programs such as the famed 4% rule make little sense in a low-rate market—and this very day’s lead story in The Wall Street Journal.

Almost breathlessly, The Journal’s lead sentence begins, “The tectonic plates of the world economy are shifting, moving the yield on the 10-year Treasury to the highest level in more than a year and shaking financial markets from Tokyo to Mumbai and Johannesburg to Sao Paulo.”

The story is all about what turmoil is in store for a world returning to the old normal.

While one of my research report’s authors, Morningstar’s David Blanchett, is somewhere on site, I’ve got another author, Texas Tech finance professor Michael Finke on speed dial. (A third author is the American College’s Wade Pfau.)

I hasten to notify Finke of the financial terror gripping markets and ask if he still stands by the findings of his 15-page report or if new higher rates change the game for savings and retirement withdrawal rates.

Calmly, Finke walks me off the brink of committing sensational news.

“It doesn’t seem as if there is any market factor that would drive real rates upward,” he tells me.

The reason is beyond the short-term ups and downs of the market. It is a fundamental demographically driven shift in demand for financial instruments that are keeping rates low, Finke advises.

“The Fed has this really fantastic chart in one of Ben Bernanke’s most recent presentations. He was showing real rates for different industrialized countries in the last 10-20 years. They really tracked each other really well despite the different fiscal and monetary policies of each country,” he says.

In other words, the recent period of low bond rates will continue indefinitely as a result of peak demand for investment products across the globe that are driving real returns on bonds and stocks down.

An older age cohort in Europe, North America and Asia are at a life stage where they need to save, meaning that it is “not realistic,” he says, to expect historical rates of return “any time soon.”

The Blanchett, Finke and Pfau study thought an initial withdrawal rate of 2.8% over a 30-year-time horizon was far more realistic than the classic 4% rate, with a (only) 50% probability of success. That low rate will necessitate boosting savings on average by 42.9% if the retiree wants to generate the same income expected under a 4% rate.

The recent boost in interest rates does not change that.

“We assumed in that study that real rates were going to drift back up,” because it is hard to imagine them going any lower than they were in recent years.

So despite the recent volatility in markets, advisors should beware: Their clients need to save longer and harder.